Monetary Policy and Food Prices

Jason Henderson Omaha Branch Executive Federal Reserve Bank of Kansas City

The opinions expressed are those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System.

The most asked question of a Fed economist:
• What will interest rates do in the next six months? • The answer:
– FOMC Statement, November 2, 2011
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The Balancing Act of Monetary Policy

Sustainable Economic Growth (Unemployment)

Price Stability (Inflation)

Market fundamentals drive ag prices. Monetary policy is an amplifier.
U.S. Corn Inventory and Farm Price
35.0 30.0 25.0 20.0 15.0 10.0 5.0 Percent of annual use U.S. Stocks-to-Use Ratio (Left Scale) Average Annual Farm Price (Right Scale) Dollars per bushel 7 6 5 4 3 2 1

0.0
1990
Source: USDA

0
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

What are the Implications for Agriculture?
Agriculture’s “Golden Eras” emerged during low interest rate environments.
• Through a weak dollar, farm incomes surge in low interest rates environments. • Farmland values boom as low interest rates boost the capitalization of farm incomes.
• The “Golden Eras” of agriculture
– 1910s: low rates used to finance WWI – 1970s: low rates to stimulate growth – 2000s: low rates used to combat “Jobless Recoveries”

High farm incomes in low interest rate environments.
Farm Incomes and Interest Rates
125.0 100.0 75.0 50.0

Constant 2005 dollars (billions)
Yield on 1 Year Treasury adjusted for inflation (Right Scale)

Percent

7.5 5.0 2.5 0.0

25.0
0.0 1970 1975 1980

Real Net Farm Incomes Less Government Payments (Left Scale)

-2.5
-5.0 2005 2010

1985

1990

1995

2000

Source: Henderson and Briggeman (2011), “What are the Risks in Today’s Farmland Market?” Main Street Economist, Issue 1.

In 1900, only a few counties had land values with more than $1000 per acre.
Real Farmland Values in 1900

$3,000 or more
$2,000 to $3,000 $1,000 to $2,000 $500 to $1,000 $500 or less
Source: USDA

By the end of WWI, $2000 to $3000 per acre was common.
Real Farmland Values in 1920

$3,000 or more $2,000 to $3,000 $1,000 to $2,000 $500 to $1,000 $500 or less
Source: USDA

By the end of the Great Depression, land values were back to 1900 values.
Real Farmland Values in 1940

$3,000 or more $2,000 to $3,000 $1,000 to $2,000 $500 to $1,000 $500 or less
Source: USDA

By 1970s, productivity gains had boosted farmland values.
Real Farmland Values in 1969

$3,000 or more $2,000 to $3,000 $1,000 to $2,000 $500 to $1,000 $500 or less
Source: USDA

Farmland values surged in the 1970s.
Real Farmland Values in 1982

$3,000 or more $2,000 to $3,000 $1,000 to $2,000 $500 to $1,000 $500 or less
Source: USDA

Within 5 years, farmland values dropped back to 1969 levels.
Real Farmland Values in 1987

$3,000 or more $2,000 to $3,000 $1,000 to $2,000 $500 to $1,000 $500 or less
Source: USDA

Today, robust energy and agricultural prices spur cropland value gains.
Non-irrigated Cropland Values
(Percent change 2010:Q2 to 2011:Q2)

Source: Agricultural Finance Databook, Federal Reserve Bank of Kansas City

What are the Implications for Agriculture?
• The Benefits
– Farm incomes are high – Farmland values boom

• The Costs
– Food prices escalate, especially for the poor. – Depending on your perspective, food vs. fuel.

Soaring global food prices start to ease
World Food Prices
260
240 220 Index

260

2011 2008 2010 2009

240 220

200
180 160

200
180 160

140
120 J F M A

140
120 J A S O N D

M

J

Source: FAO of the United Nations

Yet, U.S. food prices continue to rise, especially for food consumed at home.
U.S. Food Price Inflation
10 8 6

Percent change from previous year
Food Away From Home
Food at Home Overall Food Prices

10 8 6

4
2 0

4
2 0

-2
-4 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

-2
-4

Source: Bureau of Labor Statistics

Why is there a difference between world and U.S. food price inflation?
Commodities account for a smaller share of processed foods.
Farm share of U.S. food dollar Beef products Milk products Fruits and vegetables Bread Corn flakes 45 cents 30 cents The U.S. Food Marketing Bill

25 to 28 cents
4 cents 4 cents

Corn syrup
Source: USDA

3 cents

1960s to 1970s 1) Farm value 33% 2) Labor 29.5%

2008 1) Labor 40% 2) Farm value 16%

Why is there a difference between world and U.S. food price inflation?
Wealthy nations eat more processed foods.
Per capita fast-food expenditures (2005) U.S. Canada United Kingdom Japan Brazil China India
Source: USDA and Euromonitor

Percent

Packaged Foods Share of Food Expenditures 2005 52

60 50 40 30 20 10 0
High-income Upper-middle income Lower-middle income

$492 $387 $199 $108 $ 26.3 $ 7.4 $4.3

40

26

Rising food prices stress household budgets, especially the poor.
Food Share of Household Expenditure by Country, 2010
Algeria Pakistan Jordan Egypt India Brazil China Japan Germany Canada U.S. 6.8 11.0 14.8 24.8 22.3 27.7 38.0 40.6 43.7 41.9

9.8

Poorest 20% in the U.S. spend 35% of household income on food.
20 Percent 30 40 50

0
Source: USDA

10

Food price inflation is projected to slow.
Commodity Overall Food Food away from home Food at home Meats Dairy products Fruits and vegetables Sugars Cereals
Source: USDA

2011 3.5 to 4.5 3.0 to 4.0 4.0 to 5.0 6.5 to 7.5 5.0 to 6.0 3.5 to 4.5 2.5 to 3.5 4.0 to 5.0

2012 2.5 to 3.5 2.0 to 3.0 3.0 to 4.0 3.5 to 4.5 3.5 to 4.5 3.0 to 4.0 2.0 to 3.0 4.5 to 5.5

Food vs. Fuel
What we know: Ethanol is based on mandates, tariffs, and subsidies. Ethanol policy is being scrutinized again. Will the answers be different?
•What are the public benefits? •Does it reduce our dependence on foreign oil? •Is ethanol environmentally sustainable? •Can we afford it? •How long before advanced ethanol is viable? •What is the impact on global food prices?

What are the Risks for Agriculture?
• Future inflation
– Inflation rose in 2011
• Headline CPI inflation: 3.9% over the past year. • Core CPI inflation: 2.0% over the past year.

• Yet, forecasts suggest slower inflation in 2012. • Inflation expectations remain stable.

Ultimately, velocity is the key to inflation.

Inflation is based on money and velocity. Quantity Theory of Money
Price = Money * Velocity

Quantity

Definition of Inflation: Too much money M chasing V too few goods Q

The monetary base is not money supply.
Growth in Monetary Aggregates
500 450 400 Index (Jan 2000=100) M2 Monetary Base 500 450 400

350
300 250 200 150 100 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

350
300 250 200 150 100

Source: Federal Reserve Board of Governors

Banks are holding monetary base in excess reserves.
Excess Reserves in Depository Institutions
1.8 1.6 1.4 1.2 1 0.8
0.6 0.4 0.2 0 Jan-00 Trillion dollars

When will inflation start?
Banks start lending Consumers start spending Businesses start investing In short, if excess reserves fall before the Fed balance sheet.
Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Source: Federal Reserve Board of Governors

Conclusions
• Market fundamentals drive market prices, monetary policy is an amplifier. • Agriculture’s “Golden Eras” emerged in low interest rate environments. • Agriculture enjoys booming farm incomes and land values, but … • Urban consumers bear the burden of higher food prices. • Velocity will shape inflation in the future.

The key is bank lending, consumer spending, and business investment.

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